Japan rescinds war on deflation (Part 2)

This post is a guest contribution by Rebecca Wilder*, author of the of the News N Economics blog.

Marshall Auerback will be featured from time to time here on News N Economics. He is a dedicated author at the New Deal 2.0 (see his biography here). Take some time to read his postings at the New Deal 2.0 – he gives interesting perspective on the European Union, Emerging Europe, Chinese and U.S. policy/politics, and more.

The new budget will require additional debt issuance of Y44.3 trillion – within the Government’s expected band, but still at a level that will raise Japan’s debt-to-GDP ratio to nearly 195 per cent.

It’s quite a significant amount of spending. The fact that new debt exceeds tax revenue is irrelevant from the solvency perspective; it’s only interesting insofar as it illustrates how depressed aggregate demand remains in Japan. As you rightly note, there is no risk of sovereign debt default in Japan because Japan can always issue as much debt as it wants in its own freely floating non-convertible currency. As Bill Mitchell has noted

“the interesting part of the story is that there is now a discrete policy shift going on as a result of the political changes in Japan that arose from the last election – that is, the ascendency of the Democratic Party of Japan (DPJ). The shift will see the government reduce its obsession with public infrastructure development as a vehicle for huge fiscal injections and instead put the spending power into poor households. ” This is very supportive of aggregate demand and income growth.

The BOJ’s actions, by contrast, are nothing more than moving numbers around on a spreadsheet. Arguably, the 0% interest rate policy in Japan has exacerbated the deflationary pressures in the economy. Virtually all of the debt held by the Japanese non-government sector is public, rather than private, so the loss of the so-called “fiscal channel” via sharply lower interest rates, has been very significant. Additionally, low rates impart a deflationary bias because they reduce the holding costs of inventory and reduce the required returns of capital. These are wonderful from a supply side perspective, but disastrous from the demand side.

The important point as Bill Mitchell, Warren Mosler, Richard Koo and I have argued previously is that it recognizes its on-going role to plug the spending gap left by non-government saving (and the export collapse) and it recognises it has the capacity as a sovereign issuer of its own currency to run large deficits. In this sense, the Japanese government is placing a premium on keeping unemployment low and is resisting pressures from the deficit hawks, the neo-liberals, and the horribly incompetent ratings agencies (all of which should be abolished).